A top Federal Reserve official on Monday floated the idea of raising the central bank's inflation target, suggesting that the Fed might need to pursue higher inflation because of the low interest rates around the world.
John Williams, the president of the Federal Reserve Bank of San Francisco, wrote in a research letter published Monday that governments might need to change both monetary policy and spending programs to better "cope" with the fact that interest rates are likely to stay historically low.
He suggested two ways that the Fed might respond: One, by raising the Fed's target for inflation, which has been set at 2 percent since 2012. By raising inflation, the Fed would force interest rates to rise. That would give the Fed "more room to maneuver," Williams suggested, for instance by cutting interest rates in the case of a downturn. The Fed currently doesn't have the option to cut rates much because its short-term interest rate target is already near zero.
The Fed likely would meet political resistance and public skepticism if it aimed for higher inflation, however.
Williams also raised the possibility that the Fed could simply target total nominal economic output, a revolutionary idea that has gained some credence among academics and private-sector economists in recent years.
Any such change would be for the Fed to consider only over a lengthy period of time, Williams explained. "You don't change horses in the middle of a stream," he noted.
Although Williams is not a voting member of the Fed's monetary policy committee this year, he is sometimes perceived by investors as being close to the center of opinion among Fed members.
The replacement for current Fed Chairwoman Janet Yellen in her previous role as the head of the San Francisco Fed, Williams has performed academic research on the question of why interest rates are so low and what short-term interest rate might ensure stable prices.
In his letter, Williams noted a range of factors holding back demand for funds and thus interest rates on loans, including aging populations, slower economic growth, investor demand for safe assets and "a more general global savings glut."
In addition to reconsidering monetary policy, governments should reform spending programs so that more money is spent automatically during economic downturns, through programs such as unemployment insurance, Williams suggested. That added fiscal stimulus would help stabilize the economy when interest rates are so low that the central bank is constrained.